The Myth of the Unchanging Value of Gold

The Free Market 32, no. 7 (July 2014)

According to mainstream economics textbooks, one of the primary functions of money is to measure the value of goods and services exchanged on the market. A typical statement of this view is given by Frederic Mishkin in his textbook on money and banking. “[M]oney ... is used to measure value in the economy,” he claims. “We measure the value of goods and services in terms of money, just as we measure weight in terms of pounds and distance in terms of miles.”

When money is conceived as a measure of value, the policy implication is that one of the primary objectives of the central bank should be to maintain a stable price level. This supposedly will remove inflationary noise from the economy and ensure that any changes in money prices that do occur tend to reflect a change in the relative values of goods and services to consumers. Thus, for mainstream economists, stabilizing a price index based on a basket of arbitrarily selected and weighted consumer goods, e.g., the CPI, the core CPI, the Personal Consumption Expenditure (CPE), etc., is a prerequisite for rendering money a more or less fixed yardstick for measuring value.

This idea — that a series of acts involving interpersonal exchange of certain sums of money for quantities of various goods by diverse agents over a given period of time somehow yields a measure of value — is another ancient fallacy that can be traced back to John Law. Law repeatedly referred to money as “the measure by which goods are valued.” This fallacy has been refuted elsewhere and rests on the assumption that the act of measurement involves the comparison of one thing to another thing that has an objective existence, and whose relevant physical dimensions and causal relationships with other physical phenomena are absolutely fixed and invariant to the passage of time, like a yardstick or a column of mercury.

In fact, the value an individual attaches to a given sum of money or to any kind of good is based on a subjective judgment and is without physical dimensions. As such the value of money varies from moment to moment and between different individuals. The price paid for a good in a concrete act of exchange does not measure the good’s value; rather it expresses the fact that the buyer and the seller value the money and the price paid in inverse order. For this reason neither money nor any other good can ever serve as a measure of value.

Unfortunately, advocates of a gold-price target wholeheartedly embrace this mainstream doctrine while giving it an odd twist. They begin with the wholly unsupported assumption that one commodity, gold, is stable in value and that, therefore it can serve as the lone guiding star — or “The Monetary Polaris” as Nathan Lewis terms it — for Fed monetary policy. According to Steve Forbes, writing in the introduction to Lewis’s Gold: The Monetary Polaris, real gold standards have one thing in common: “They use gold as a measuring rod to keep the value of money stable. Why? Because the yellow metal keeps its intrinsic value better than anything on the planet.”

Louis Woodhill, in a Forbes column, writes in a similar vein, explaining that “[t]he fundamental validity of the gold standard rests upon the premise that the real value of gold remains constant over time. ... The most fundamental thing about a unit of measure is that it be constant. ... Gold is not money, and it should not be money. However we can and should use gold to define the value of the dollar.”

These passages reflect an almost mystical belief that the “intrinsic” or “real” value of gold is, for all practical purposes, eternally unchanging, unaffected by the continual flux of human valuations, stocks of resources (including gold itself ), technology, and entrepreneurial judgments that define the essence of the dynamic market economy. Furthermore no definition is ever given of what exactly the concept of “intrinsic value” means or in what units it is expressed.

Historical experience clearly shows that the value of gold vis-à-vis other commodities has fluctuated over the centuries, even when gold has served as the monetary standard. This was certainly the case, for example, when the US returned to the gold standard after the Civil War. From 1880 to 1896, US wholesale prices fell by about 30 percent. From 1897 to 1914 wholesale prices rose by about 2.5 percent per year or by nearly 50 percent. This rise came about mainly as the result of a nearly doubling of the global stock of gold between 1890 and 1914 due to discoveries of new gold deposits in Alaska, Colorado, and South Africa, and improvements in the technology of mining and refining gold.

Proponents of gold-price targeting thus seem to ignore both theory and history in assuming that once the dollar price of gold has been fixed, the value of money itself becomes forever stable and immune to the influence of market forces of supply and demand. Inflation and deflation are, therefore, ipso facto banished from the economy. This implies that any changes occurring in the quantity of money under a fixed-gold price regime are to be construed as benign and stabilizing adjustments of the supply of money to changes in the demand for money. Steve Forbes writes: “The fact that a foot has 12 inches doesn’t restrict the number of square feet you have in a house. The fact that a pound has 16 ounces doesn’t restrict your weight, alas — it’s a simple measurement. ... The virtue of a properly constructed gold standard is that it’s both stable and flexible — stable in value and flexible in meeting the marketplace’s natural need for money. If an economy is growing rapidly such a gold-based system would allow for rapid expansion of the money supply.”

In other words Forbes’s “stable and flexible” gold standard would facilitate and camouflage an inflationary expansion of the money supply that would, according to Austrians, distort capital markets and lead to asset bubbles. The motto of our current gold-price fixers seems to be: “We want sound money — and plenty of it.”